In 1716 the French royal finances are heavily in deficit after the expensive wars of Louis XIV. The regent, the duke of Orléans, is persuaded by a Scotsman, John Law, to undertake an experiment in banking. Law has published in 1705 a treatise entitled Money and trade considered, with a proposal for supplying the nation with money.

Law's theory is that a national bank issuing notes as currency will have the effect of stimulating the economy, while also lowering the public debt. He is allowed to set up the Banque Générale in 1716 for this purpose. In 1717 he launches a separate venture, the Louisiana Company, to develop the French territories in the Mississippi valley.

At first both enterprises thrive, and Law acquires ever greater responsibilities and commercial power. All the French chartered trading companies, to the East Indies and China, to Africa and the West Indies, are brought under his control, as also is the national mint and the collection of taxes. As more and more people rush to invest in this octopus of an enterprise, Law has the power and the freedom to issue shares and bank notes at will to keep his creature alive and well.

The result, by 1719, is rapid inflation and speculative hysteria. The price of Law's shares rise 36-fold, from 500 to 18000 livres. At the end of 1720 the bubble bursts. Law flees from France, dying in penury nine years later in Venice.

The experience of 1720 leaves the French with a lasting distrust of national banks with the power to issue paper money. Not until Napoleon needs funds for his war effort, in 1800, is the Banque de France finally established - long after the same step is taken in other European countries.

While Law's shares are still rising, in the early months of 1720, the same phenomenon is occurring across the Channel in England - where the shares of the South Sea Company have an equally irresistible allure to speculative investors.

South Sea Bubble: 1720

The company at the centre of England's notorious bubble of 1720 has been in business for nearly ten years. It was established in 1711 as the South Sea Company, with a monopoly of British trade to South America and the Pacific. It first becomes a fashionable share to buy in 1718, when the king becomes a governor.

The bubble begins only in 1720, prompted by a scheme for the company to take over much of the national debt. This is done by offering holders of government bonds the chance to exchange them, at an extremely beneficial rate, for shares in the company. The price of the shares begins to rise, in a self-perpetuating frenzy of excitement which takes no account of any underlying value.

By August the price is eight times higher than in January, but the slump once it begins is even more rapid. In December the shares are back to their January level, representing a fall of nearly 90% in a few months (even so, this is a modest crash in percentage terms compared to the contemporary Mississippi Bubble in France).

As many fortunes are made on the way up as are lost on the way down. But in an age without financial regulation the turmoil and the pain inevitably raise suspicions of corruption. The king and his German mistresses, along with certain government ministers, are noticed to have done well.

Meanwhile the investment frenzy has made possible the launch of a great many other speculative schemes, the majority of which (unlike the South Sea Company itself) are fraudulent. In these cases fortunes pass directly from the gullible to the criminal.

The bad taste left by these experiences leads to the rapid passing of the Bubble Act before the end of the year. For a little over a century, until repealed in 1825, it restricts the forming of joint-stock companies, harming the honest entrepreneur as much as deterring the confidence trickster. In practice legal loopholes are found. Many joint-stock companies are set up under other names in Britain during the 18th century, particularly in insurance.

The Bubble Act is repealed in England in 1825 because it is a time of economic boom and there is increasing public pressure to invest. But the act is repealed without any alternative regulation to replace it.

The public is exposed anew to the dangers inherent in fraudulent schemes, particularly with the Industrial Revolution gathering pace and requiring ever more capital. Not until the Joint-Stock Companies Act of 1844 are effective regulations introduced.

The Wealth of Nations: 1776

During the second half of the 18th century visible changes are occurring in Britain as a result of the developing Industrial Revolution. Where previously land has been the traditional source of wealth, and the purchase of land the natural investment for anyone with a spare fortune, money is now being put into manufacturing enterprises.

In 1771 the greatest of the new entrepreneurs, Richard Arkwright, opens the first custom-built and water-powered cloth mill at Cromford. In the same decade the investment of another entrepreneur, Matthew Boulton, shows signs of prospering. He has put money into the manufacture of James Watt's steam engines. The first batch are delivered to their purchasers in 1776.

The wealth of the nation is being diverted into new and productive channels, in a process which will lead eventually to the emergence of a society organized on capitalist principles. The process is observed with a clear analytical eye by the Scottish philosopher Adam Smith. In the year when Boulton and Watt deliver their first engines, Smith publishes a treatise which becomes the definitive statement of classical capitalism and the free market.

In the five books of his Inquiry into the Nature and Causes of the Wealth of Nations (1776) Smith ranges over many of the basic concerns of political economy.

The first book points to labour rather than land as the source of a nation's productive wealth, and pinpoints two other elements which affect prices in a developed society - rent and profit. The second book analyzes the role of capital in enabling labour to be productive.

The remaining three books discuss broader issues of the proper role of government in an economy. Smith comes down strongly against the prevailing theory of mercantilism, which takes for granted that there is an economic advantage in protecting one's own trade by restrictive measures against other nations' goods or merchant ships.

Smith argues instead that economic benefit derives from the natural competition of the market place, where people should be free to follow their own best interests without government interference. He believes, with the optimism of the 18th century, that public good will follow naturally from the untrammelled pursuit of private interest.

Smith recognizes the necessary role of government in many fields - defence, justice, and the infrastructure of canals and roads. His arguments against interference relate to the economic sphere, where the government should merely prevent monopolies (which distort the market). His treatise profoundly influences the laissez faire policy of the 19th-century and its revival in the Thatcher-Reagan era.

Sections are as yet missing at this point.

Boom and bust: 1877-1893

The pattern of boom and bust in late 19th-century America is a dramatic example of what has since come to seem an endemic aspect of capitalism. This pattern is different from speculative mania of a purely financial kind (as in the South Sea Bubble, where investors are the only losers).

An almost invariable ingredient in each cycle is too much credit extended by banks. Sometimes a sudden collapse in market prices triggers the panic which ends the boom (a drop in the price of cotton has this effect in the USA in 1819 and 1837). A natural disaster can have the same result. So can a single event of mainly symbolic importance in the financial markets. All these characteristics are seen in America between 1877 and 1893, in a saga beginning in the midwest.

It is a misfortune that during the boom years in the midwest, from 1877, there is an unusually high level of rainfall on the plains. Growing crops here seems easy. And land on which to grow them is easily come by, thanks to the Homestead Act of 1862 (granting 160 acres of public land in the west to any family farming it for five years) and the lavish allocations of territory to the railway companies.

In practice land is often acquired from middlemen and speculators, but this does not deter the streams of immigrants coming west on the railways (among them now Scandinavians, Germans, Hungarians and Poles). In this mood of optimism mortgages are easily available. Financiers on Wall Street also see profit in the west.

Loans are needed too for the livestock and seeds and implements and rolls of barbed wire which a pioneer farmer needs before he can get to work (the family house is a lesser priority - the 'sod cabin', cut from turf, becomes a feature of the plains). Agents of eastern banks travel through Dakota, Nebraska, Kansas and western Texas offering attractive terms.

The new towns borrow money too, for streets and buildings appropriate to their growing wealth. Next year's crop will enable the pioneer families to pay their local taxes and to service their debts, while the value of their land goes steadily up. And for the ten years of good rainfall, from 1877, the crop duly plays its part.

A double disaster strikes in 1887. In January an unprecedented blizzard sweeps the plains, piling up vast snowdrifts against the barbed wire fences. Cattle perish in their thousands. In the spring the open range seems empty of life.

This is followed by a summer of drought, which proves to be the pattern for the next ten years. The harvest is a fraction of its usual amount, at a time when the international price of wheat is falling (by 30% during the 1880s). Interest on loans cannot be met. With confidence gone, the supply of easy credit dries up. For the first time convoys of Conestoga wagons head eastwards, bearing slogans such as 'In God We Trusted, In Kansas We Busted'.

Though money has been lost, these faraway events are as yet more painful on the plains than in the offices of Wall Street (established by now as the nation's main financial centre). Recognizing a potential crisis, financiers and politicians focus their concern on whether the nation's currency is sound. This soon develops into a disagreement about the relative roles of gold and silver in the management of the economy. But there is a general consensus that the government must hold a minimum reserve of $100 million in gold.

In April 1893, shortly after President Cleveland enters office for the second time, the reserve falls below this magic figure. This turns out to be the symbolic moment which provokes the crash.

Investors rush to turn their assets into gold, and panic feeds on panic. By the end of 1893 the federal gold reserve is $80 million and the shutters have come down on 600 banks, 74 railway companies and more than 15,000 other commercial enterprises. The collapse in the economy brings widespread unemployment and hardship. In 1895 the banker J.P. Morgan provides the government with $62,000 to bring the still falling reserves back to $100,000.

The next presidential election, in 1896, is fought on the issue of gold versus silver. The Republican candidate, William McKinley, is on the side of gold. He wins, but the tide is probably turning anyway. In the summer of 1896 gold is found in the Klondike. Confidence slowly recovers.